What to Look for in a Financial Advisor

Financial services structures and costs can be confusing to navigate, even for me, and this is my career. Going into an initial meeting with a financial advisor for the first time can feel a bit like stepping into a cage fight. Your guard is up, but your opponent is a seasoned veteran that does this every day. How do you prepare when the person across from you is highly trained and you may not be? After reading this, you will be armed with all of the resources you need to make it a fair fight.

Who you choose to hire can have an immense impact on the advice you receive, and ultimately how successful you will be in achieving your financial goals. But how do you know who to trust? It comes down to 3 key areas: Fee Structure, Standards of Care, and Education & Experience.

FEE STRUCTURE

As you might suspect, much of what you should consider when hiring someone is how they are getting paid. This is important for 2 reasons

It will affect your overall cost.

It will be an indicator of the extent of conflicts of interest that may be present when your advisor makes recommendations.

It is true your financial advisor needs to get paid for the services they provide. However, these costs should be designed to be transparent and mitigate conflicts of interest. The best way to do this is to hire an advisor that is fee-only. To find out why, let’s explore the 3 most common types of fee structures:

Commission

I can’t tell you how many times a client would tell me that their advisor doesn’t charge them anything for advice. All this means is that you don’t see what you are paying. You are still paying, and oftentimes paying more than those that see the fee directly on their statement.

Most likely this type of advisor is working on a commission basis, also known as Sales-Related Compensation. This advisor gets paid each time they sell you an investment, an insurance policy, or an annuity. The issue here is not the advisor getting paid, rather, they have an inherent incentive to put you into products that pay them and ignore others. This can create a conflict of interest in the client-advisor relationship. You want the solution that is best for you, but may be subjected to only a few options that your advisor gets paid to sell.

Another pitfall here can be the level of service you receive after you are put into that product. Your advisor may be paid for the transaction, but not for the ongoing service afterwards. At least until the advisor has a new product to sell you.

Fee-Based

A fee-based advisor accepts both commission and fees. This one can be tricky, because it sounds like “fee-only”, but is not the same. In fact, the CFP Board uses the term “fee and commission” to describe this type of compensation and lays out guidelines to discourage any CFP® professionals from suggesting that being fee-based is in any way the same as being fee-only. According to the CFP Board, a firm that represents their firm is fee-based:

a) May not use the term in a manner that suggests the CFP® professional or the CFP® Professional’s Firm is fee-only; and

b) Must clearly state that either the CFP® professional or the CFP® Professional’s Firm earns fees and commissions, or that the CFP® professional or the CFP® Professional’s Firm are not fee-only.*

Fee-Only

A fee-only advisor accepts payments from one source – directly from clients. That means your advisor never gets compensated by any 3rd parties via commission, referral fees, mutual funds, or any other method. According to the CFP Board:

A CFP® professional may represent his or her or the CFP® Professional’s Firm’s

compensation method as “fee-only” only if:

a) The CFP® professional and the CFP® Professional’s Firm receive no Sales-Related Compensation; and

b) Related Parties receive no Sales-Related Compensation in connection with any Professional Services the CFP® professional or the CFP® Professional’s Firm provides to Clients.*

So why is it important? By hiring an advisor that has a fee-only compensation structure, you know exactly how much you are paying, and you also know who is paying your advisor – you. This helps to eliminate conflicts of interest that can exist when an advisor may receive a larger commission check by selling products that may not be best for you.

To ensure you are working with an advisor that has a compensation structure designed to reduce conflicts of interest, I recommend hiring an advisor that is fee-only.

EDUCATION AND EXPERIENCE

You would be surprised at the low barrier of entry to calling yourself a “financial advisor”. Nothing more than passing 2 short exams – the Series 7 and 66 is all that is required. These exams do not cover many topics that are essential to financial planning, can be passed with just a few months of studying and do not require a college education. The reason is that the financial services industry has historically rewarded individuals who are good salespeople and not necessarily well-educated, experienced, competent financial planners.

The CERTIFIED FINANCIAL PLANNER™ certification is widely considered the gold standard among financial planners. The board requires a certificant to complete a rigorous curriculum and pass a 6 hour exam that covers all relevant aspects of financial planning – including investments, taxes, risk management, retirement, and estate planning. The board also requires at least 3 years of industry experience and a college education. In addition, CFP® professionals have sworn to uphold a strict code of ethics and standards of conduct.

To ensure you are working with someone that has experience, relevant training, and committed to putting client’s interest ahead of their own, I recommend working with a CFP® professional.

STANDARDS OF CARE

Essentially, there are two standards of care in financial services – suitability and fiduciary. These terms get thrown around a lot, especially recently with added regulatory pressure from the Department of Labor and CFP Board. So what exactly do they mean?

Suitability

The suitability standard means that the recommendation needs to be in line with your time horizon and risk tolerance to be considered “suitable”. For example, if you are retired and drawing income from your investments, a “capital preservation and income” portfolio may be suitable. However, this does not mean that the advisor is required to recommend the “capital preservation and income” portfolio that is necessarily the best one for you. They may be allowed to recommend investments that pay them a higher commission than alternatives and still be in compliance with the suitability standard. This standard is often found at larger banks and brokerage firms.

Fiduciary

This means that your advisor is legally required to put your interest ahead of their own. Remember that portfolio from the previous example? In this case, the advisor would be required to not only recommend portfolio that meets “capital preservation and income” objectives, but also perform due diligence and make that recommendation from the perspective of being in the best interest of the client. This is the standard that all Registered Investment Advisory (RIA) firms are held to.

To reduce conflicts of interest, and know your advisor is required to act in your best interest, I recommend working with an advisor that is held to the fiduciary standard.

WHAT TO LOOK OUT FOR

To arm you further, I’ve compiled some common red flags I’ve seen over the years to look out for:

Quick to Recommend

Language to look out for: On first meeting “I recommend the A shares of XYZ fund because they provide my clients great returns and low cost in the long run”.

Why it’s a bad sign: If the advisor is eager to provide recommendations before knowing your full situation, they are likely just after a sale. This can be a sign of seeking a commission rather than taking the time to understand what may be the best fit for you. This can often times be seen in the form of recommending account transfers, mutual funds, insurance, or annuities early in the client-advisor relationship. Your advisor should seek first to understand your complete financial picture before recommending any changes.

Consolidation

Language to look out for: “It will be convenient for you to have everything in one place, and I can keep an eye on it for you”.

Why it’s a bad sign: Has your advisor truly already done all the work needed to know every option and cost in your current plan, and compared those to what they have to offer, to ensure they are offering a better solution? It is true in many cases it can be convenient to have all your accounts in one place. But first ask yourself “Is this convenient for me, or for the advisor? Is the advisor receiving extra compensation if I transfer my accounts?” This one can be particularly problematic if you have great investment options in your 403(b) or a pension plan that will meet your retirement income goals, but are told to transfer them anyway. Once you transfer these types of plans, you can’t move them back and those options are lost forever.

Obvious Commission Based Investments

Language to look out for: “I recommend an annuity.” “I recommend a whole life insurance policy.” “I recommend you buy the A shares of this mutual fund because it will save you money over the long term.”

Why it’s a bad sign: These are probably the most well known high commission products in the financial services industry. It is a sign your advisor may be more interested in cashing a commission check than making a recommendation that is in your best interest. Those commission checks come from somewhere, and you are footing the bill when their may be lower cost or better alternatives. Once an advisor sells one of these products, they are often moving on to the next prospect to earn the next commission check. This also means you may be susceptible to a lower level of service until the advisor has another product to sell you.

Limits Scope

Language to look out for: “I act in a fiduciary capacity on retirement accounts.” (or anything that limits the scope of their fiduciary responsibility).

Why it’s a bad sign: This simply indicates the advisor is not acting as a fiduciary in all other instances they do not specifically indicate. For advisors that use the suitability standard in some instances and fiduciary in others, it can be difficult to know when your advisor it acting in your best interest and when they may not be held to that same standard.

The Referral

Language to look out for: “I rely on referrals, therefore you can rest assured I’ll do what is best for you because it is important to the success of my business”.

Why it’s a bad sign: The advisor is saying that your interests are aligned simply because you may refer them a client in the future. This only highlights the problem – they are looking out for themselves. This doesn’t mean an advisor asking for a referral is a bad thing, it’s not. Implying that the chance to earn a referral replaces a fiduciary standard is the problem here.

WHAT TO LOOK FOR

The good news is there are a lot of advisors that are competent, transparent, will put your interest ahead of their own and minimize conflicts of interest.

Still not sure how to tell if your advisor meets the criteria? To make it simple, ask the advisor:

Fiduciary

“Do you act in a fiduciary capacity, at all times?” Anything other than “yes” means there are likely instances in which the advisor may not act in a fiduciary capacity.

Fee-Only

“Is your compensation structure designed to be fee-only?” Again, anything other than yes means you may be pivoting into a sales-pitch.

CERTIFIED FINANCIAL PLANNER™

You can verify the advisor is a CFP® professional by looking for the CFP® marks after their name, or by finding them on the https://www.letsmakeaplan.org/ website. Or of course, simply ask.

If you’re looking for a fee-only, fiduciary, CFP®, a good place to find advisors that meet these criteria are:

Newsletter

Disclosure: Pulse Financial Planning (“PFP”) is a registered investment advisor offering advisory services in the State of Minnesota and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by PFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of PFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.